The equity party may be over soon

With another round of quantitative easing, many believe that the S&P will shoot straight over 1500. The author of this article believes that this is only a short-term trend and there will eventually be a decline of such magnitude and strength that QE will not be able to save the market.

By Avi Gilburt
Sept. 17, 2012, 4:34 a.m. EDT
Market Watch

Back in June of 2012, when we only experienced a 3-wave decline into the 1,260 region on the S&P (our initial target for the decline set in late April), I said that we should be looking to go long the market with the potential to move as high as 1,440.

Although many bears had been trying to short this market since the mid-1,300's, now that Chairman Bernanke has pulled out his checkbook, they have either been stopped out of or affirmatively covered their short positions, expecting that the party has just begun, and we are heading straight over S&P SPX -0.41% 1,500 in a big way.

Over the past week, I have read how some of the most ardent of the bearish analysts have gotten stopped out of their short positions and have no interest in re-shorting this market, with expectations of much higher levels to be seen. Many of them are even turning bullish.

But for weeks, we have noted how the larger market perspective has been way too bearish to begin to see the large decline we have been anticipating, and we maintained that we had higher targets to attain.

Now, everyone seems to be looking up to much higher levels while we are now hitting our upside targets; and everyone now believes that the Fed will simply cause a melt up in asset prices well beyond our targets.

While they certainly could be right, I personally think that the short-term party may now be just about over, and, as I noted last week, the currently euphoric mood on Wall Street could very well change in the near term.

But I want to be clear and note that I still believe this is only going to be a corrective decline to shake out the “hopium”-induced long positions before the market does rally to potentially new all-time highs. Yet, if I am right, the expected decline into October will likely be of such magnitude and strength that it will bring the bears back out of hibernation. Many may even assume that, with a strong decline seen immediately after QE has been begun again, QE won't be able to save the market.

But our focus isn't QE3, 4 or 10; rather, it’s on market sentiment as represented in the wave structure. In fact, since the Fed has now indefinitely opened its checkbook, it means that we now have QE-Ad Infinitum. Yet, a market decline seen in the face of such unlimited stimulus bolsters our position that it is not the Fed that runs the market, as almost everyone seems to believe, but it is sentiment that causes markets go up and down, and such movements in sentiment are patterned and controlled by Fibonacci mathematics.

As for the market specifics, in the last “Weekend Update,” I said that "my two target regions, as now slightly modified based upon the current wave action, are 1443-1451ES and 1462-1467ES."

I also noted that there is a market fractal that is pointing toward the higher region, which made the higher region a stronger possibility. Earlier in the week, as we were hovering around the 1430ES level and the set up was cloudy as to whether the market was going to retrace 10-15 points before heading up to the higher target region, I said that an immediate break out over 1437ES (without breaking 1425ES support) was the indication we would be heading up toward the 1,460's.

Well, it is clear that we broke through 1,437 and headed straight up toward the 1,460's.

Early Friday morning, when we had a question as to whether wave iii of this final rally had completed, I noted that 1452ES (on the December contract, to which we switched on Thursday night) would be support that would have to be broken to signal a larger wave iv, and a move over 1,458.50 would target 1468ES for the top of our extended wave iii.

That morning, we dropped to the 1453ES level and then rallied to a high on Friday of 1468ES on the nose. The market then began what seems to be a 14-point corrective decline to the .382 retracement region of that wave iii. While the market can still provide us with a deeper decline for a wave iv, my expectation is that it should maintain support over the 1447ES level before heading up one more time to complete wave v.

As for our target for the top of wave v, it CAN be as high as 1485ES.However, if we see the standard extension for wave v, wherein it would be equal to wave i, then the lower target level of 1475ES will provide us with the top.

Although we are now discussing targets that are a bit higher than the targets I set in June, I want to digress a moment and add in a couple of words about setting targets.

When we practice Elliott Wave analysis in setting targets, we have to remember that we use the Fibonacci extensions that are most commonly targeted in order to set a reasonable upside target. When additional "hopium" is seen in the market, it leads to higher Fibonacci extensions beyond the standard ones, which clearly make us raise our targets.

But this doesn't mean that the pattern has changed. Rather, it simply means that the market has just reached a higher extension than the standard extensions we expected to be hit back in June. Always remember that market analysis is about identifying high probability patterns and not about absolutes.

As you can see from the alternative count, which is also supported by the fractal I noted last week, the market top may already be in. Initial confirmation would be seen by a decline below the 1445ES level, and confirmation for the larger corrective decline seen upon a break below 1432ES. For now, our target for the coming corrective decline will be the 1,320 to 1,350 region. It is from this region that I expect the rally up toward the 1,600 region.

While I know it is emotionally difficult to short a market when positive sentiment is so high, you can always chose to wait for the break of support and then short a corrective retracement.

Since I expect that the next decline will be a c-wave of a larger b-wave flat, we should see a 5 wave decline. This would allow you to either short, or add shorts, on the wave 2 retracement, which we will likely see within about two to three weeks' time, depending upon how long it takes until we see our market top.

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